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US housing starts data shows sector has bottomed out

Post Time:Jul 20,2009Classify:Industry NewsView:250

I HAVE to say I was very pleased to see Wall Street clear its final hurdle for the week, which again suggests to me this is much more than just another short-covering rally. While the earnings from GE, Citi and Bank of America were arguably low quality, the market chose to look forward and believe the worst is behind corporate earnings and the global economy.

I think out of all the risky earnings days this US second-quarter reporting season, Friday was the one that could have made the market nervous again and triggered profit-taking. The fact it didn’t, and the Dow Jones Industrial Average held a solid 7.3 per cent gain for the week, is a very, very bullish signal in my way of assessing things.

Speaking to traders in New York, they again tell me the general feeling is changing to one of glass half-full. Bad news isn’t having the same impact as it once did and “non negatives” are now seen as positives. A classic example of this would be Friday’s new home construction data, which showed a 3.5 per cent rise (582,000 units versus 530,000 expected), yet remains around half of what it once was! However, the absolutely clear fact is that US housing starts have bottomed, and that sent up the PHLX Housing Index (+1.24 per cent) and copper to $US2.41 a pound.

While China is the true swing factor in commodity demand, make no mistake that US housing market sentiment is a very big swing factor in commodity trading. Just about every week I see some investor on CNBC telling me that copper prices are a factor of US new-home construction because copper is used in new homes. Fair enough, but I think it’s more about sentiment towards copper rather than genuine supply-demand fundamentals.

If American investors start believing the US new-home construction cycle has bottomed, then they will buy commodities, led by copper. That is exactly what happened on the London Metal Exchange on Friday, with copper the best performing metal and anyone who produces a lot of it seeing support. Rio Tinto (RIO) gained 3.5 per cent, BHP Billiton American Depositary Receipts (BHP ADRs) are up at $35.60, while Xstrata rallied 4.28 per cent and Freeport 3.12 per cent. This positive copper sentiment should spill over to OZ Minerals (OZL) and Kagara (KZL) here today in the more leveraged pure plays.

The “reflation trade” was on everywhere in commodities, with WTI oil bottoming out and bouncing back to $US63.56. I reckon you have seen the trading lows for oil and I am looking for WTI to head back to $US75 to $US80 a barrel over the next six months. That will drag up Woodside (WPL), Santos (STO), Oil Search (OSH), Arrow Energy (AOE), Karoon Gas (KAR) etc, and won’t hurt BHP sentiment either.

The next leg of this in commodities is all the bears reversing their calls. Even this morning I read a few bears backing off on their negative commodities calls because commodity prices were rallying during the seasonally weak northern summer. Many other commentators had suggested an underweight stance in commodities over the northern summer, but I think that is backfiring badly as leading economic indicators turn up.

If anything, the unseasonal strength in commodities is a very bullish signal. All those who shorted copper at $US2 a pound on the view that the price would fall once the Chinese State Reserve Board stopped buying must be scratching their heads. I really like the look of the “red metal”, particularly as we move into a more carbon-neutral world and copper's electronic capabilities become more widely utilised. The red metal is actually the "green metal" and that is why I am so bullish on copper.

While on commodities, it’s worth noting the Baltic Dry Index has its biggest weekly gain since May on demand for iron ore carriers. The Baltic Dry Index gained 19 per cent for the week, driven by a 26 per cent increase in iron ore cape sized leasing rates. This correlates with the strength in the spot iron ore price which hit $US91 a tonne into China last week.

You see, I believe the Chinese have totally stuffed the iron ore price contract negotiations. There are rumours of some mills breaking ranks from CISA and agreeing to “temporary” deals with BHP and RIO, while data shows you that Chinese steel production is back above record levels.

The massive Chinese stimulus aimed at steel-intensive infrastructure is working, and spot iron ore prices will play further catch-up to Chinese steel production. With just about all global iron ore production expansions on hold after the GFC, ask yourself where the supply is going to come from to feed this powerful Chinese steel industry demand?

Buy Fortescue Metals Group (FMG), RIO and BHP in that order for leverage to iron ore. I remain of the view that being short bulks into a reaccelerating Chinese economy is pretty much a death wish. Our core strategy is to be long everything China is short, and there is nothing they are more short of than high grade iron ore.

My whole strategy revolves around looking forward and taking educated risks. Since March, that has worked very well, but I am convinced we are only just getting started in the recovery/reflation trade. As I scoured the internet over the weekend looking for anyone who agreed with that view, I found a piece by Jim Cramer from CNBC’s Mad Money show. If you have a spare 10 minutes today, watch the Cramer video on JPMorgan’s results and listen to what he says. Think what you will of Cramer, but I think this is absolutely brilliant and dead accurate in terms of investor psychology.

That video link feeds into our major theme today, why Australian banks are a short, medium and long-term buy ahead of a period of super-normal profits.

Stay bullish people. This rally will extend as more and more people realise the worst is behind us and cash is the underperforming asset class. Remember: FOMO +FONI = FUHR.

Charlie Aitken is executive director of Southern Cross Equities.

Source: http://www.theaustralian.news.com.auAuthor: shangyi

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